Malaysia’s latest stimulus plan? The Koran

It wants to be the center of the fast-growing market for Islamic investments, especially bonds. Officials in Kuala Lumpur think the global Islamic market–which HSBC Holdings Plc estimates is worth more than $200 billion–will bring big benefits to their economy over time.

“This is a very important initiative for our financial industry but also our country,” says Sulaiman Abdul Rahman Taib, executive chairman at RHB Bank Bhd.

Islamic, or Sharia, law bans the paying or receiving of interest. That’s leading more banks and finance houses to develop products that incorporate fees into transactions. In addition to HSBC, Citigroup Inc. and Standard Chartered Plc have joined the growing ranks of global powerhouses creating Islamic divisions.

“The idea is to tap a vast and underutilized source of capital,” says David Vicary, director of financial services at Deloitte KassimChan in Kuala Lumpur. “Much of it sits in banks or under mattresses. You take it and create a market and it will lead to a big asset class. Not to mention a new and thriving business for Malaysia’s economy.”

Seeking debt market

Malaysia is angling to have such a debt market centered here in Kuala Lumpur. It would create jobs–for new market participants, regulators, con­sultants, lawyers, journalists, back office workers, etc.–and would bring Malaysia closer to its goal of becoming a global financial hub.

The nation effectively launched the global Islamic bond market in June 2002, when it issued $600 million of five-year securities denominated in US dollars. Kuala Lumpur is drumming up interest for another Islamic issue; this time it wants to sell $690 million of debt denominated in euros.

Kuala Lumpur is a frequent borrower in global markets and its stable economy is attracting the attention of foreign investors. The nation’s benchmark stock market is up 12.7 percent this year, putting it ahead of returns in markets including the Dow Jones Industrial Average.

Another reason for Malaysia to lead the Islamic debt charge is its more liberal views on Sharia-compliant investment. To thrive, an Islamic bond market must be a liquid one that can compete with other securities. Cognizant of that, Malaysia’s secular government wants to attract non-Muslim investors, too.

Sharia-compliant debt

“Our experience has shown that Sharia-compliant products can’t exist in a vacuum,” says Jamaludin Jarjis, Malaysia’s second finance minister. “They must coexist and compete with conventional products. At the end of the day, it’s the cost of raising the funds that matter.”

Well put. In order for a global Islamic market to matter, it must offer trading opportunities for short-term investors, while appealing to longer-term buy-and-hold ones, too.

Islamic issuers simultaneously must appeal to two very different sets of people–those investing strictly for religious reasons and conventional investors looking for a liquid, attractively priced market in which to profit.

An Islamic bond is essentially a zero-coupon, one that pays no stated interest rate and pays only the principal portion at a stated date in the future. There are myriad zero-coupon bonds outstanding around the globe. Only if non-Muslims see value in Sharia-compliant debt will they buy it. It’s that simple.

Investment rules

Officials in Kuala Lumpur understand the magnitude of the challenge. Meeting with Asian financial ministers in Manila recently, Jamaludin cited Malaysia’s experience with Islamic bonds as part of the effort to build regional debt markets. Getting other Asian countries interested in issuing Sharia-compliant debt would go a long way toward growing the asset class.

Yet all this is an uphill climb. One challenge for Kuala Lumpur is reaching consensus with Muslim nations on investment rules. Some scholars, for example, believe Sharia law may not allow for the day-to-day trading of debt securities. A secondary market is necessary if non-Muslim investors are going to buy the debt; some Persian Gulf officials see things differently.

The primary market isn’t doing much better. In the Middle East, Islamic debt issues are few and far between. The bonds are generally held to maturity, making the market extremely illiquid. The lack of an inter-bank market doesn’t help. Islamic law also can make it difficult for investors to use financial options, derivatives or other hedging tools routinely found elsewhere.

Striking a balance among Muslim leaders is a tall task, but Kuala Lumpur is optimistic. Officials also are hopeful Islamic finance will produce vital trickle-down effects for the economy.

The benefits

Sixty percent of the nation’s 23 million people are Muslim. Many who comply with Sharia law wait until they have saved enough money to buy a house or car outright, since interest is banned. The spread of Islamic finance and banking will make these large purchases more possible, boosting the economy.

A similar dynamic could play out in Middle Eastern nations. Stable oil prices have helped the region’s economies but many still carry high levels of public debt. Eager to attract more foreign investment, Gulf States may see Islamic debt as a means of embracing capitalism on their own terms. The market also could help foster a more robust business climate in the region.

“Islamic central banks, investors and individuals are sitting on huge pools of untapped liquidity,” Vicary explains. “Doing something with it could have big economic benefits.”